Peace of mind can come with a price

Humberto CruzTribune Media Services columnist

My wife, Georgina, has spent close to $4,000 the past two years for "investment insurance" she didn't need.

But because this insurance gave her the confidence to put more money in stock funds, her investments, even with the insurance cost, are worth $40,000 more than they would have been with her former ultraconservative portfolio.

When I say insurance, I'm talking about the so-called living benefits offered by many variable annuities.

The most common benefits are that, no matter how your investments perform, you'll be able to withdraw a minimum amount (such as a percentage of the amount invested) for "x" number of years, receive a minimum income for life or receive your principal back after so many years.

These guarantees, backed by the insurance company issuing the annuity, are a safety net. What you want, as has happened in Georgina's case, is for the annuity's return to be high enough so the guarantee is not needed.

That's why cost matters. The cost of the guarantee reduces your return. Benefit details vary widely, so it's difficult to generalize what is a fair cost.

Georgina pays 0.75 percent of her account value a year to guarantee minimum annual withdrawals that can go up but not down until we both die.

All total, she pays 1.4 percent a year in annuity insurance expenses.

I can live with those costs but not much more (some annuities charge 1.4 percent a year without living benefits, a charge I find excessive).

Moshe Milevsky, associate professor of finance at York University in Toronto, has published papers suggesting living benefits may actually be underpriced. Products such as annuities with living benefits "effectively create downside protection in the critical early years of retirement" when investment losses can quickly deplete a portfolio, Milevsky wrote in the July issue of the Journal of Financial Service Professionals.

This assumes "the insurance fees charged for this protection are not too high," Milevsky said. A paper he published last month calculates that a living benefit with even an "abnormally high" charge of 2 percent a year would still reduce a retiree's chances of running out of money. (Of course, it would also reduce the actual investment return.)

Beyond the hard-core math, there is peace of mind. A recent survey of 1,000 Americans ages 55 to 80 with at least $75,000 to invest found that fear of stock-market losses keeps many from investing in the diversified portfolios they need to generate adequate returns. Most would be interested in products with guarantees and, among those who are, most would pay 1 percent a year.

"The problem is fear of investing," said Mathew Greenwald, founder of the research firm Mathew Greenwald & Associates, which conducted the survey for NAVA, formerly the National Association for Variable Annuities.

Admittedly, one can be skeptical of research conducted for those who have a stake in the outcome, and insurance companies have funded much of Greenwald's and Milevsky's research. But both men are well-respected, and facts are facts.

Among the facts: 44 percent of the people surveyed want little or no risk, even if it means lower returns, and 32 percent would feel very insecure if their investments lost as little as 2 percent a year.

Also, 56 percent said concern about risk is a major reason for limiting their investments in stocks, and 26 percent acknowledge they invest too conservatively (as Georgina did).

"One of the things these guarantees do is give people the confidence to invest in the market," said NAVA President Mark Mackey. "It boils down to how much you are willing to pay for them."

Humberto Cruz is a columnist for Tribune Media Services. E-mail him at yourmoney@tribune.com.